Raising tax rates doesn’t always increase revenue

An increase in taxation is not the same as an increase in government revenue. In arguments over fiscal policy, lawmakers and journalists should choose their words carefully.

A National Public Radio reporter recently fell into the trap. He described the feverish debate over US fiscal policy as a choice between cutting spending and raising revenue, by which he clearly meant hiking tax rates.

His wording was prejudicial. It echoed propaganda common during arguments over the economic policies of former President Ronald Reagan in the 1980s.

Reagan campaigned for and eventually won reduction by Congress of the top marginal tax rate to 28% from 70%. He based the initiative on “supply-side economics,” which emphasizes suppression of tax rates along with regulatory restraint to stimulate economic growth and broaden the tax base.

A prominent symbol of supply-side economics is “the Laffer Curve,” named for economist Arthur B. Laffer, who never claimed to have invented the idea but became linked with it by a napkin sketch he drew during a discussion with administration officials.

The Laffer Curve suggests that government revenue is nil at 0% and 100% tax rates and that the rate yielding maximum revenue lies somewhere in between. Laffer argued that rates, under conditions of the day, were not optimal and that lowering them would raise revenue for the government.

Economists still argue about this. Reagan did lower tax rates, the economy did enter a long period of growth, and government revenue did increase. Some observers attribute the growth to other factors. Some observers also dismissed the Reagan tax cut as ineffective before it took effect. They were the ones who, euphemistically, said “revenue” when they meant “higher taxes.” [Native Advertisement]The Laffer Curve’s main insight is that tax rates and government revenue can move in opposite directions. The important variable is economic response, which needs to be taken into account in decisions about fiscal policy.

Higher tax rates don’t always mean more money for the government. Assuming they do can be costly.